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Uncommon Sense: Back to School

A company we know is sending its executives and managers back to school to learn accounting. Why? Because those execs and managers were making decisions without understanding the financial implications. They didn't know whether their decisions would produce profit or loss because they had no idea of how the costs and benefits would be accounted, or how they would fit into an income statement and balance sheet.

You can just imagine the financial health of this firm. So everybody, regardless of their technical or administrative skills, will go back to school to learn financial management and accounting.

Based on our experience with many different firms and industries, we're convinced this dearth of understanding of how "books" are kept is endemic. Here are some examples.

The president of a capital goods manufacturer, a bright guy with a Ph.D., said: "I never did understand the concept of overhead." In this case, a significant part of product cost came from the overhead account, which was nothing more than a black box to the firm's senior exec. That made for some fun cost cutting!

The president of another capital goods firm faced with negative absorption said: "We've just got to get more hours in the shop to absorb overhead." To him, the overhead application rate was a constant, and the problem was in making the budgeted amount of hours, not excessive overhead cost, insufficient sales, or the actual cost of outsourcing vs. in-sourcing.

The president of a service industry firm with a long tenure in management consulting said: "I don't worry about cash flow. I focus on profit and that takes care of everything." He also said: "We don't have 'overhead'; we just charge everything directly to projects."

The distinction between profit and cash seems to be very foggy to many execs, but try paying bills with profit! This same misunderstanding happens with income statement and balance sheet data. Income statements are more fun, but balance sheets let you pay the bills.

The president of a large multinational conglomerate, who should have known better, said: "I don't even consider exchange rates. There's nothing I can do about that anyway." This firm was making products in Sweden to be sold in central Africa with results reported on financial statements in the United States. It's no surprise these were really ugly financial statements and that most sourcing decisions were dreadfully wrong.

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Senior executives have the ultimate responsibility for making decisions that can make or break the company. Too often, they don't understand the basic criteria for making those decisions nor their effect on the financial success of the firm. Many managers fail their firms and themselves because they lack even rudimentary knowledge of accounting. Consequently, they often make decisions that are in the worst interests of their firms.

This is not to say all CEOs should be CPAs. Far from it. CPAs have their own shortfalls as CEOs, shortfalls perhaps even more drastic than the engineer who doesn't know what overhead is or who is completely illiterate about income statements and balance sheets. However, regardless of how imaginative and technically skilled, the engineer-CEO must also know how success is measured to become successful.

We're sure that sending its managers back to school will pay off for the firm that recognized that understanding how the "books" are kept is critical to its success.

They have our congratulations.

What's your opinion? Whether you agree or disagree, Don Ewaldz will welcome your comments. You can contact him via the Bourton Group's Web site. Just point your browser to www.bourtongroup.com and click on "Contact Us".